Ethics & International Affairs Volume 20.2 (Summer 2006): Book Reviews: The Debt Threat: How Debt Is Destroying the Developing World [Full Text]

Jul 28, 2006

Lydia Tomitova (reviewer)

Last year’s G-8 meeting in Gleneagles marked a major political commitment to cancel the debts that nineteen poor, heavily indebted countries owe to the IMF, the World Bank, and the African Development Bank. If all goes according to plan, these countries will have, in total, $40 billion that they could spend on poverty reduction, health care, and education, rather than on servicing their debts. Like the establishment of the Heavily Indebted Poor Countries (HIPC) Initiative in 1996 and its subsequent “enhancement” in 1999, the G-8 agreement is a product of the pressure on governments exerted by a massive global mobilization of citizens, led by religious officials and civil society campaigners. Yet, at least in contrast to other global campaigns, such as the antiwar movement, it seems initially odd that countries’ external debt—on its face a purely financial issue that is the outcome of contracts voluntarily entered into by lending countries or international banks and borrowing states—should have been the catalyst for such political mobilization.

Noreena Hertz’s The Debt Threat seeks to explain why debt is a political issue of relevance to ordinary citizens of both debtor and creditor countries, and outlines a general agenda and specific proposals for overcoming the global debt problem. The book is an engaging, accessibly written account of the history of debt’s political economy. According to Hertz, global debt amounts to a “threat” to the populations of developed and developing countries alike. It is a threat to persons in poorer indebted countries because it diverts national budget resources that could be spent on vital social needs and raises the risk of severe economic crises in case of a default. Debt also threatens citizens of developed countries, whose continued prosperity depends on a stable, default-free global economy. Finally, it is a threat to the future of humanity, because governments that overexploit natural resources to repay debts contribute to global environmental degradation, and states marked by high political instability as a result of poverty and high inequalities, to which debt is a contributing factor, can become breeding grounds for terrorism. Hertz advances three justifications for the urgent need to address the global debt problem. First, creditors, not just borrowers, are responsible for the accumulation of unsustainable debts. Second, it is unacceptable that unsustainable debts undermine governments’ ability to guarantee the basic rights of their citizens. Third, ignoring the effects of high indebtedness on the global economy and of the debtor countries’ feeling that they have been treated unjustly poses a collective threat.

Hertz appeals for an acknowledgment that “there are some debts that are so clearly illegitimate . . . that countries should never be asked to honor them” (p. 178). She lays out the case for this claim by examining the roles of the various international lenders—governments, private creditors, and multilateral institutions. During the Cold War, the U.S. and West European governments often lent for strategic purposes to repressive or severely corrupt regimes, such as those of Iraq, Zaire, Indonesia, and Ivory Coast. Developed countries’ export credit agencies also subsidized the foreign investments of their home country companies, disregarding the corruption that many of these projects exacerbated. Egregious examples abound: in 2002, Acres, a company supported by the Canadian export credit agency, was convicted in a Lesotho court for having paid $260,000 in bribes to the former CEO of the corrupt Highlands Dam Project, which, Hertz points out, displaced hundreds of subsistence farmers and adversely affected the lives of 27,000 people. The practice of bailing out the companies for failing projects and adding the claim to the total bilateral debt effectively shifted the costs of the lending countries’ highly questionable practices entirely to borrowing countries. When Iraq’s government stopped honoring its contract with Udhe, a corporation that funded a project to develop a chlorine plant in Iraq, which Saddam Hussein subsequently used to develop chemical weapons, the U.K. export credit agency paid Udhe the money owed to it and added this sum to the bilateral debt it claims against Iraq.

To explain why the IMF and World Bank have been able to contribute to the debt crisis, Hertz begins from the economic implication of endorsing the vision of the U.S. economist Harry Dexter White in the design of these institutions. First, it meant that, under the fixed exchange rate regime, the burden of adjustment fell on countries with a balance-of-payments deficit—in contrast to Keynes’s proposal, under which the burden would be shared with surplus countries. As the United States became a deficit country in the 1960s, however, it became increasingly untenable to maintain the peg of the dollar (the global anchor currency) against gold, posing the danger that countries would start replacing their dollar reserves with gold. The United States chose to devalue the dollar and exit the fixed exchange rate system rather than risk losing its gold reserves—thus, effectively terminating the fixed exchange rate regime. It is worth adding that since the dollar remained the currency of international transactions, decisions about the price of global capital were put into the hands of the U.S. Federal Reserve, through its mandate to set the interest rate on borrowing in dollars.

Second, under White’s vision, loans were to be temporary and accompanied by demands for instituting policies that could correct a country’s balance of payments by lowering inflation through a reduction of public spending, imports, and employment (though, it should be noted, conditionality was not part of the original Articles of Agreement). By the early 1980s, IMF and World Bank lending had surpassed that of commercial banks and structural adjustment conditions on loans became tighter. While Hertz acknowledges that “when the timing is right and social safety nets are in place, the kind of policies insisted upon by the Bretton Woods institutions can lead to positive outcomes,” she argues that in developing countries they resulted in a decline of growth and increase in poverty and unemployment (p. 103). More damagingly, Hertz claims that the Fund and Bank were not unaware of the likelihood of negative consequences of these programs to the poor.

For these reasons, Hertz argues that as much as 60 percent of existing claims should be deemed illegitimate because they are “odious”—that is, funds were lent to a regime that lacked democratic consent; the regime used the money to no benefit or to the harm of the people; and the lender knew of this possibility at the time of entering the contract. For such cases, she maintains, not only is there no ethically valid claim to repayment, but also the lender, by aiding and abetting abusive practices of which it was aware, may owe compensation to the people who were harmed as a result of the odious loan. (This claim is rigorously defended in Kunibert Raffer, “International Financial Institutions and Financial Accountability,” Ethics & International Affairs 18, no. 2 [2004], pp. 61–77.) This forms the basis of the claim for the suit currently filed by 169 South Africans in U.S. courts against eight major U.S. banks, which are alleged to be vicariously responsible for the abuses under apartheid by virtue of having lent to the regime (p. 183).

Yet, despite the numerous compelling examples of illegitimate contracts that Hertz cites, the question of the ethical validity of debts has been of little, if any, practical significance to agreeing on reforms. Virtually all debts have gone through several rounds of restructuring—that is, the original stock of debt has been revalued and bought several times on the “secondary” market, introduced with the Brady Plan in 1989 (named after the U.S. secretary of the treasury), in which debt obligations could be sold by the original issuers to buyers, who could then continue to trade the debts among themselves. In other cases, a restructuring took place after the IMF provided new loans to countries for the purpose of servicing the claims of the original lender, similarly assuming the claim on a loan from its original contractor. As a result, it is often difficult to establish the ethical responsibility of the holder of a claim to an odious loan.

Hertz adds another reason to cancel debt: creditors’ rights should not be allowed to override the fundamental human rights of the population of a borrowing country. Insisting on debt repayment, she argues, makes citizens of creditor countries complicit with poverty’s grave consequences. Stated otherwise, debt should be canceled, or at least suspended without charging interest, until the debtor regains solvency, when repaying the debt would make it impossible for a government to secure the basic rights of its people. The claim that debt should be canceled when its repayment conflicts with the realization of basic rights has been the central focus of the campaign for debt cancellation. How plausibly and comprehensively Hertz makes the case for this claim, and how activists have pursued it in practice, thus warrants close examination.

The HIPC Initiative, adopted in 1996 and subsequently expanded in 1999, both times under pressure from an international coalition of civil society organizations that came to form the Jubilee campaign, represented the first institutional attempt to assess what constitutes an unpayable debt. As Hertz points out, however, the employed debt sustainability criterion has been defined in terms of overprojected levels of growth (as in the case of Ethiopia, which was projected to grow annually by 6 percent against Africa’s 2.1 percent average annual growth) and overoptimistic export projections, not taking into proper account commodity price fluctuations in export industries and trade obstacles posed by the subsidy practices of the United States and the European Union—that is, the design of the criterion did not reflect the considerations that are relevant to enabling a government to meet the basic rights of its citizens. Moreover, civil society has argued, the initiative included only some of the countries that would qualify for debt cancellation if a basic rights criterion were employed. Countries such as Kenya, Angola, Kyrgyzstan, Vietnam, and Haiti, among others, have been left out.

In part, the reason why reforms to date have reflected a limited ambition on the part of creditor countries is related to the question of responsibility. It is difficult to establish, when a government cannot secure the basic rights of its citizens, if this is the fault of its own mismanagement or if blame should be attributed to the pressure from international creditors driven by a narrow concern for loan repayment. Hertz recounts the case of the cholera epidemic that spread throughout Latin America in the early 1990s as an example of the latter proposition. In 1991, President Fujimori of Peru—the epicenter of the epidemic—instituted economic austerity policies and more than doubled the country’s monthly debt payments to $150 million, at least partly in an attempt to restore the country’s relations with international financial institutions. Basic sanitary necessities were put out of reach to the poorest people, and the country was also left with no budget for emergency health care to contain the epidemic. Hertz’s critics would likely claim that there are various possible allocations of resources within a national budget, and that no matter what the external pressure, a government always has some freedom to move resources from less pressing to urgent priorities. Blame, in this account, cannot be squarely placed on the IMF; Fujimori’s government should take responsibility for not spending the $100 million it is believed it would have cost to prevent the crisis. Still, even if one remains unpersuaded by such a response, it is plausible to argue that it was Fujimori’s obligation to the Peruvian people to suspend unilaterally debt repayments in order to prevent a health emergency—after all, it is difficult to imagine that any penalty by the IMF could have resulted in graver consequences for Peru than those of the cholera epidemic.

Like debt advocates, Hertz shies away from these complexities, perhaps because they have been opportunistically exploited by international creditors, leading citizens to believe that corrupt overseas governments are nearly entirely responsible for the plight of their peoples. Yet, acknowledging them should not embarrass global justice advocates. Indeed, there are good reasons to take a closer look at the countries that are slated to benefit from the G-8’s cancellation proposal. Mauritania, which was originally on the list, and which, Hertz notes, spends twice as much on debt repayment as on education, was dropped following a military coup in August 2005. It is questionable, however, whether the country should be given cancellation even had the coup not occurred. Mauritania has long been on the watch lists of human rights organizations for its now legally banned, yet continually tolerated, practice of slavery (see Amnesty International, Report 2005: Mauritania; available at Providing debt relief to the government would likely strengthen its position vis-à-vis antislavery advocates within the country. Hertz notes that Japan’s government continues to provide low-interest loans to Burma’s regime—and indeed, activists ought to call for discontinuing this practice, rather than for canceling the country’s debts, since doing so may undermine the efforts of Burmese advocates at resisting the country’s military junta. Otherwise, the continued legitimacy of advocacy efforts for debt cancellation would be seriously threatened. Although it is likely that some very poor people within these countries will benefit from their governments’ increased budgetary resources, the goal of ensuring the immediate alleviation of human suffering should be left to the efforts of humanitarian aid organizations, who are best positioned among willing international actors to deliver aid to those who need it the most with the least negative impact on a country’s distribution of political power.

It should be acknowledged that debt cancellation activists, including Hertz, have chosen an absolutist strategy—advocating for immediate and unconditional cancellation for all countries where debt repayment diverts resources from needed social spending, regardless of the human rights records of their governments—in large part because of the adversarial nature of political negotiation at the global level. In a world of highly unequal power distribution, with no existing mechanisms to force the privileged to deem relevant the concerns of the global poor, negotiating political change starts with both sides advancing maximum demands in the knowledge that they will have to compromise. In other words, although activists campaigned for unconditional cancellation on behalf of Mauritania, they ultimately did not protest the removal of the country from the list of countries that will benefit from the G-8 proposal. Simply put, progress on debt has been extremely slow due to the technical intricacies and lack of transparency in global financial policy. Opportunities abound for last-minute, behind-the-curtains alterations of seemingly bold agreements that change significantly their substance and practical impact. One need look no further than the G-8 deal: it has recently become known that the promise to cancel 100 percent of the debts of the beneficiary countries applies to the debts they owe to the IMF through the end of 2004, while the World Bank plans to cover debts through 2003 only. For the group of countries that are due to see their debts cancelled this year, this would fail to cancel $1 billion—the yearly amount that governments have committed in aid to Africa toward the achievement of the Millennium Development Goals. Countries such as Cameroon and Malawi, which are part of a second group of HIPC countries that are expected to qualify for cancellation, will continue to owe millions to the World Bank since they are presently expected to see their debts cancelled no earlier than 2007. Hertz is clearly aware that the arguments based on illegitimacy and securing basic rights are unlikely to convince enough people in creditor countries to bring about the needed pressure for change. Unless citizens of creditor countries see their own interests under threat, successful and timely mobilization is extremely unlikely. For this reason she argues that debt cancellation is also an important measure to prevent a global recession. The probability of external economic shocks, whether in the form of a terrorist attack in Europe, the effects of higher global interest rates as a result of the United States’ current heavy borrowing, or an increase in the price of oil, is not to be discounted. Such caution is warranted in light of the history of the 1980s debt crisis that unfolded as a result of the United States’ policy response to the 1979 oil price shock. The ground for it was laid by commercial banks’ indiscriminate lending in the 1970s, underlined by lack of due diligence on the belief that sovereigns simply don’t go bankrupt.

There is no evidence that such a threat is imminent, however—indeed, the oil price hikes of 2005 seem to have been warded off rather successfully by developed economies, and President Bush declared in his 2006 State of the Union address that the United States has decided to make independence from oil a national priority (though independence from foreign energy supplies was also a national goal of President Nixon’s Project Independence, announced in the 1974 State of the Union address). What is more likely is that developing countries may begin to repudiate their debts unilaterally, as Argentina did when it defaulted on its debt in 2001. Indeed, in January 2006, Jeffrey Sachs, the director of the UN Millennium Project, appealed to African countries to repudiate their “unaffordable” $201 billion debt if developed countries fail to cancel it: “If they won’t cancel the debts, I would suggest obstruction by yourselves” (quoted in Philip Ngunjiri, “With a $201b Debt, Africa Will Never End Poverty, Says Sachs,” East African, January 25, 2006; available at If debtor countries act on his advice, the political costs to creditor governments would be significant, at least in the short term.

Hertz is more convincing in making a case that sound economic management in international financial relations would enhance global security. Because of its social consequences, unpayable debt is an important political issue. If not addressed, it could be easily hijacked by populist extremist leaders and organizations employing extreme tactics of political violence.

The Debt Threat is forward-looking in intention—its discussion of illegitimate lending, poverty, and collective threats is meant to bring “truth, reconciliation, and regeneration,” as Hertz’s final chapter is titled. In this spirit, Hertz outlines a proposal to form trust accounts to manage the cancellation of debts in a way that would ensure that governments do not misuse the resources that become available to them, without relying on the controversial conditionality of the IMF. As part of the condition for allowing a bankruptcy settlement to go forward, a country will be required to deposit an amount equal to its monthly debt payments into this trust account, from which the money will be transparently allocated to social expenditures on poverty alleviation, health care, and education. Hertz argues that these trusts are likely to deliver because they will be administered by civil society representatives, who, she claims, are less likely to be beholden to the interests of domestic elites. Since payments into the fund will be made in monthly installments, potential abuses could be halted in time with in-progress audits. An idea, currently being refined by civil society, is that these trusts could be peer-run: their governing body will include representatives from neighboring countries, which are likely to have a stake in their effective operation, as progress on social goals is vital for ensuring regional prosperity. If properly instituted, this model may bring an added benefit—the exchange of knowledge among regional governments about transparent and effective governance practices that they themselves could design. Imaginative ideas of this kind that seek to correct the flaws in the design of the international financial system hold the greatest promise for a lasting solution to the global debt problem.

—Lydia Tomitova, Carnegie Council for Ethics in International Affairs

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